A Donor-Advised Fund for You

By

Amy Feldman

November 30, 2013

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Sarah Libbey, 56, is president of Fidelity Charitable, the nation's largest sponsor of donor-advised funds with assets of more than $10 billion. One of the biggest trends she's seeing is that donor-advised funds have gone upscale, ever more commonly paired with trusts.

No longer just a prepackaged giving tool for the masses, donor-advised funds are increasingly being used by high-net-worth families as part of a broader philanthropic strategy that may include donating complex assets or using charitable trusts.

"A couple of years ago, we recognized that our type of program was starting to catch on among high-net-worth clients and their advisors as an alternative to setting up a private foundation, and we believe that is fueling our growth," Libbey says.

Sarah Libbey of Fidelity Charitable
Jason Grow for Barron's

Some sales hype is in there, but also the truth. In the first nine months of 2013, the U.S.'s generous poured nearly $1.3 billion into Fidelity's donor-advised funds, a 5% increase over the total in the same 2012 period. Outgoing grants, meanwhile, also hit $1.3 billion, representing a 33% rise in what went to charities directly.

Of course, not just Fidelity is seeing such healthy increases. Donor-advised funds as a group -- Schwab Charitable, Vanguard Charitable, and others -- have all been sucking in assets, despite the sluggish economy's general impact on most forms of giving. According to a recent report by the National Philanthropic Trust, the total assets parked in donor-advised funds last year surpassed $45 billion. That's a 55% increase in giving since the spooky days of 2009.

It's not hard to see why. Donor-advised funds are straightforward: You make an irrevocable donation of as little as $5,000, and you get the immediate charitable tax write-off. The gift grows tax free in the fund, allowing you to pass money to charities over time, as you see fit.

One of the big attractions for philanthropic-minded families is that the costs of a donor-advised fund are less than a private foundation, and for big givers, the tax benefits are often far greater than can be had at the family vehicle.

Fidelity, for example, charges 0.6% in annual administrative fees; the fee falls to 0.19% or lower for assets above $5 million. (For more comparing of donor-advised funds with family foundations, see Penta, "Tax Hike Silver Lining," July 17, 2013.)

Meanwhile, the tax write-off for charitable cash contributions to donor-advised funds is capped only at the much higher 50% rate of adjusted-gross income, versus the 30% cap at foundations. (For publicly traded securities, those caps fall to 30% and 20%, respectively.)

Naturally, there is some bad news, too. Donor-advised funds have legal limitations on how and to whom they can distribute funds, restrictions that private foundations simply don't have. That matters a lot for many folks.

But one of the more interesting wrinkles emerging today is the pairing of a charitable trust with a donor-advised fund. Here's how: Instead of naming an operating charity, like the Red Cross or Doctors Without Borders, as the beneficiary of a charitable trust, you name a donor-advised fund that can give to those charities.

Since donor-advised funds are programs of public charities themselves, the tax rules work exactly the same way, but you gain flexibility because of how you can direct funds to operating charities (like the Red Cross) much later in the distribution process. Think of a donor-advised fund as a tax-efficient holding tank for philanthropic largess at some point later in life.

Libbey says the trust strategies she sees at Fidelity's donor-advised funds involve both charitable remainder trusts -- in which the donor gets distributions for a specific period and then the "remainder" goes to charity -- and charitable lead trusts, in which the charity gets the income payments for the term of the trust and then the remaining assets goes to the grantor or an heir.

At a time of higher tax rates and low interest rates, both instruments can be attractive planning tools, albeit for different reasons. (For more on current tax plays related to charitable giving and donor-advised funds, "Tax Moves to Make Now".)

Let's assume that an entrepreneur has a highly appreciated asset, and wants to give it away, but still needs the income it throws off to run his various households. His strategy would look like this: Set up a charitable remainder trust, and name a donor-advised fund as the end beneficiary.

The move gives the entrepreneur all the advantages of a charitable remainder trust -- including the income stream from the asset and the ability to take a charitable deduction based on the present value of the ending balance -- while also allowing him to postpone the decision about where the remaining funds will ultimately go.

"It's an efficiency play," explains Karla Valas, managing director of Fidelity Charitable's complex-asset group. "They have total flexibility within the donor-advised fund after it gets the remainder."

Often, a donor-advised fund comes into play when the trust is winding down. In one case at Fidelity, for example, a woman who established a charitable remainder trust in her 40s decided to terminate it 15 years later, when she decided she no longer needed the income.

Rather than give a big lump sum to an operating charity, she named Fidelity's donor-advised fund as both the trust's beneficiary and the assignee of all future income that she would have received from the trust. The tax benefits of her generous gift, however, were all hers.

An alternative strategy, useful for estate-planning purposes, combines a charitable lead trust with a donor-advised fund. In that instance, the strategy is reversed, and works best when you have an appreciating asset, rather than one that already has great value.

In that case, the donor-advised fund receives income for the duration of the trust's existence, while the remaining, hopefully appreciated, assets typically pass to an heir at the time of the donor's death. With interest rates low, it's a smart way to get future appreciation for your heir out of your estate–tax free -- while also doing good.

It works nicely, too, if you have children keen to be involved in philanthropy while they await their inheritance. A family with three adult children, for example, sets up three charitable lead trusts, and then designates a Fidelity donor-advised fund as the charitable beneficiary of each of the trusts.

Each of the children is named an advisor to one of the donor-advised funds, allowing them to recommend the grants it would give. At the end of the trust's term, each of the three siblings will receive the balance of funds that remain in the trust.

There aren't any big downsides to pairing a donor-advised fund with a charitable trust, but if you already know where you want the funds to go, there may not be any reason to add this layer of complexity.

The move is ideally suited to people who want the tax advantages of a trust, whether to reduce current-year taxes or for estate-planning purposes, but feel they haven't yet spent enough thought on a worthy recipient and don't want to be stampeded into a poor decision.

Donor-advised funds are also good with complex assets, like closely held businesses, real-estate, or venture-capital investments that an operating charity might not be able to handle.

Let's assume a serial entrepreneur wants to sell a closely held business, but decides to donate it instead. Valas says that, too, is a hot play these days. "We're spending more and more time with these creative entrepreneurs," she says.

As for Libbey, her own philanthropy focuses on her alma mater, the University of New Hampshire, and the Guatemala Partnership. Having worked her way up from the Fidelity phone banks, she became president of Fidelity Charitable in 2008.

"It was a deliberate notion at that time -- and at my age at that time -- that I wanted to start understanding philanthropy more," Libbey says.

For those less clear on how they want to direct their charitable energies, however, combining a trust with a donor-advised fund is a cost-effective and practical way to get the tax benefits of a trust, while also allowing you the luxury of making your philanthropic decisions later in life, when you have the time to ponder your legacy and the twists and turns of life.

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